The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
August 15,1975 Managed Floating Managed floating aptly describes the way in which the major indus trial countries have operated in the foreign-exchange market since early 1973. As the term suggests, the objective of central-bank inter vention in the market is no longer to maintain a fixed exchange rate, but rather to minimize fluctu ations around the basic market value of each currency within an overall context of floating rates. The system seemed to work quite well for a while, but in recent months it has come under increas ing attack from France and other European countries. As an indica tion of a growing preference for a fixed exchange-rate regime, France recently joined the Europe an “ snake” currency bloc, and Switzerland, Italy and other coun tries have expressed a desire to join the bloc at some future date. Unwarranted rate movements? According to critics of the managed-float regime, exchange-rate movements over the past two years have been both excessive and unwarranted. Move ments in the value of the dollar against the European snake cur rencies and the Swiss franc have been particularly volatile, rang ing as high as 15 to 20 percent within only a few months' time. Fluctuations in the trade-weighted value of the dollar, on the other hand, have been considerably smaller, but still noticeable. Thus, while the trade-weighted value 1 Digitized for FRA SER of the dollar is now slightly above the level of February 1973, there have been a series of swings about this level, the range of variation being roughly four percentage points (plus or minus) during this two-year period. According to these critics, fluctua tions in the value of the dollar against other currencies have been much greater than could be accounted for by international differences in inflation rates or interest rates. In this view, exchange-rate changes have been primarily the result of speculative capital flows, rather than fundamen tal economic forces. While re cognizing that fluctuating ex change rates can serve to clear the market for foreign currencies, critics argue that the managedfloating system failed to achieve its basic objective—namely, to reflect relative changes in economic conditions through marketdetermined exchange rates. Again, critics contend that specu lative capital flows have had a destabilizing effect on exchange rates, requiring official interven tion in the foreign-exchange mar ket to dampen the wide fluctua tions in rates. This feeling is widely shared among central bankers, as evidenced by their actions early this year, when they forcefully intervened in the foreignexchange market to stem the speculative attack against what they deemed to be an undervalued dollar. The Federal Reserve Bank (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. of New York sold over $750 million in foreign currencies in FebruaryApril 1975—the bulk of these interventions occurring during February’s steep slide. Other central banks recorded total gross interventions of several times that amount during this period. Destabilizing intervention? Proponents of freely flexible rates, on the other hand, argue that extensive official interventions in the market themselves create excessive rate fluctuations. Insta bility may result, for example, when authorities attempt to restrain exchange-rate movements at a time when market forces are generating strong pressures for change. Private speculators, con vinced that authorities will relent if the pressure becomes great enough, act in such a way as to amplify the pressure—and once the authorities finally give way, “ overshooting” takes place. The question of whether private (or official) “ speculation” is stabiliz ing or not is basically an empirical matter. No final answers are possi ble because of the shortness of Digitized for FRA SER the period of fluctuating exchange rates, but a recent study by John Hodgson (University of Oklaho ma) nonetheless helps to shed some light on the question. (His study covers monthly movements in the U.S. exchange rate vis-a-vis the yen, franc, deutschemark, pound and Canadian dollar over the 1971-74 period.) Hodgson identi fies some instances in which private capital flows and official inter ventions had stabilizing effects on exchange rates, as well as in stances where each had destabiliz ing effects. Generally, he argues that the broad movements ob served in exchange rates tend to correspond to the rate move ments predicted by macroecon omic variables, and in this sense exchange-rate movements were not “ out of control” in the period studied. Thus, if his finding is valid, attempts to stabilize exchange rates without stabilizing underlying macroeconomic variables could contribute to exchange-rate instability. Costs and benefits A related question centers around the economic costs of exchangerate fluctuations. Prior to the adoption of managed floating, it was frequently alleged that fluc tuating rates would increase the cost of exchanging currencies in the foreign-exchange market, and that this could bring about a re duced volume of international transactions. Has this, in fact, been the case? A casual inspection of the data might suggest so. The volume of international trade last year de clined for the first time in several decades, and it is expected to continue falling in 1975. Similar ly, the gross volume of long-term bonds floated on the Euro-bond market last year was almost twothirds below the 1972 level. How ever, even the critics would not attribute these developments pri marily to fluctuating exchange rates, but rather to the basic econ o m ic forces w hich have resulted in reduced activity in nearly every country of the world. Several observers have also noted that foreign-exchange transac tion costs, measured by the spread between buy-sell rates in the inter-bank market, have doubled or tripled since the adoption of managed floating. However, this was not true of the Canadian experience with floating rates in the 1950’s. Also, this phenomenon could be less a reflection of floating rates than of other factors, such as the oil situation or the general uncertainty in foreignexchange markets generated by the collapse of the fixed exchange-rate system. Nor is it clear that the buy-sell spread has widened enough to affect adverse ly the volume of international transactions. While many central bankers and finance ministers may feel un comfortable with the present re Digitizedfor FRA SER gime of flexible rates, they also recognize the benefits accruing from it. First, the system has weath ered the various crises, such as oil and world-wide inflation, which led to the abandonment of fixed rates. It is questionable whether perfectly stable rates could ever have been maintained under the difficult circumstances of the past several years. Second, flexible rates have eliminated (or at least mitigated) the need for trade and exchange controls, and in this sense have helped support a continued high volume of international trans actions. Finally, the new system of fluctuating rates has probably helped to ease international ten sions. Foreign countries are now free to pursue a more independent course of monetary policy, and old conflicts about the U.S. role in exporting inflation and about the adjustment responsibilities of surplus (or deficit) nations sudden ly seem to have lost their rele vance. Indeed, the continued exis tence of this regime of managed floating indicates that the per ceived benefits have outweighed the perceived costs, at least to the present time. Nicholas Sargen uoj8u!qse/v\ • • uo S o jo • epBAa^ • oqepi !| b m b h • e m jo j!|E 3 . e u o z u y • e>|se|y * ) I |C 3 'O D SID U B JJ U B S 3sz on* nw aad aivd aovisod 's*n nvw ssvio 1SHIJ BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assets and Liabilities Large Commercial Banks Amount Outstanding 7/30/75 Loans (gross, adjusted) and investments* Loans (gross, adjusted)—total Security loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities O ther securities Deposits (less cash items)—total* Demand deposits (adjusted) U.S. Governm ent deposits Time deposits—total* States and political subdivisions Savings deposits O ther time deposits^ Large negotiable C D ’s 84,849 63,902 700 23,246 19,560 9,892 8,115 12,832 84,899 23,527 210 59,562 6,385 20,604 28,889 15,246 Weekly Averages of Daily Figures W eek ended 7/30/75 Member Bank Reserve Position Excess Reserves Borrowings Net free (+) / Net borrowed (-) Federal Funds—Seven Large Banks Interbank Federal fund transactions Net purchases (+) / Net sales (-) Transactions of U.S. security dealers Net loans (+) / Net borrowings (-) + Change from 7/23/75 - + + - + + - + + - - 67 6 61 214 147 11 113 41 25 200 161 564 595 45 240 79 44 28 189 Change from year ago Dollar Percent + - + + - + + - + + + + + W eek ended 7/23/75 - + 530 2,464 904 390 163 369 3,244 250 5,604 1,426 148 4,129 193 2,749 701 219 - + + - + + - + + + + + 0.63 3.71 56.36 1.65 0.83 3.87 66.60 1.91 7.07 6.45 41.34 7.45 3.12 15.40 2.49 1.46 Comparable year-ago period 1 6 7 - 39 477 438 + 1,123.3 + 1,461.8 + 1,416.5 + + + 143.6 222.6 480.3 ♦Includes items not shown separately. ^Individuals, partnerships and corporations. Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 397-1137. Digitized for FRA SER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis
@FedFRASER